Question

Inventory at the end of the year was inadvertently overstated. Which of the following statements correctly states the effect of the error on net income, assets, and stockholders' equity?
A net income is understated, assets are understated, and stockholders' equity is overstated

B net income is overstated, assets are overstated, and stockholders' equity is overstated

C net income is understated, assets are understated, and stockholders' equity is understated

D net income is overstated, assets are overstated, and stockholders' equity is understated

Answer 1

Answer:

B net income is overstated, assets are overstated, and stockholders' equity is overstated

Explanation:

The movement in the balance of inventory at the start and end of a period is as a result of sales and purchases. While sales reduces the balance in inventory, purchases increases the balance. This may be expressed mathematically as

Opening balance + purchases - cost of goods sold = closing balance

Hence, where ending inventory balance is overstated, cost of goods sold is understated. When cost of goods sold is understated, gross and net incomes are overstated. Hence owner's equity is overstated and asset overstated.